Benefits November 13, 2023

Higher Bond Yields Mean Higher Corporate Pension Funding Levels

Some pension funding models reached their highest points in decades.

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The funding status of U.S. corporate pension plans increased in October, largely due to a reduction in liabilities stemming from an increase in discount rates, which were offset by negative investment returns. According to some trackers, pension funding status is at its highest point in decades.

High Interest Rates Fuel Improvements

According to WTW’s pension finance tracker, U.S. corporate pension funding is at its highest level since mid-2001, with the funding ratio of WTW’s benchmark plan increasing 1.1 percentage points to 110.5% in October.

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The WTW Pension Finance Index tracks the performance of a hypothetical 60/40 plan. This benchmark portfolio recorded a negative 2.4% return in October, but pension obligations decreased by 3.4% for the month, resulting in the tracker’s pension funding increase.

According to Insight Investment, funded status for the top 100 U.S. corporate pension plans increased to 108.1% from 107.5% in the month. Insight Investment found that among the top 100 plans, assets decreased by 3.8% and liabilities decreased by 4.3%, resulting in a 0.6-percentage-point increase in the funded status of the average plan.

Agilis, in its pension funding briefing, reported that pension discount rates are at their highest since early 2010, rising to more than 6% for the first time in more than a decade. According to Agilis, pension plans either maintained or slightly improved their funded status in October, as liabilities declined more significantly than assets.

“Rates at the long end of the curve continued to push upward during October, with markets presumably buying into the Fed’s posturing of ‘higher for longer,’ said Agilis managing director Michael Clark in a statement. “These movements at the long end of the curve had a significant effect on discount rates, which are up approximately a full 1% from the middle of the year. This significant change in discount rates has an equally significant effect on pension liabilities, as most liabilities tend to move anywhere from 8% [to] 14% depending on the nature of the pension plan benefits and demographics.”

Clark’s statement also broached potential strategies for the year ahead.

“Looking ahead to 2024, pension plan sponsors will want to continue de-risking discussions, whether through liability-driven investment strategies or pension risk transfers (lump sums and/or annuity purchases),” Clark said in the statement. “For frozen plans, evaluating a potential plan termination should be on the radar.”

According to Aon, which tracks pension funded status for S&P 500 companies with defined benefit plans, the aggregated funded ratio for these plans increased to 103.2% from 102.4% in October. For the year, these funded ratios are up from 98.2%. According to Aon, pension assets declined 2.8% in October. With the 10-year Treasury rate increasing 29 basis points and credit spreads widening by 8 basis points, interest rates used to value pension liabilities increased to 6.16% in October from 5.79% in September.

Milliman, in its 100 PFI pension tracker, found that pension funding status for the largest 100 corporate pension plans rose 1.4 percentage points in October, to a 2023 high of 104.2%. A 36-bps increase in discount rates to 6.2% offset a 2.68 dip in October.

“October marked a new funding ratio high for the year,” wrote Zorast Wadia, author of Milliman’s report. “While plan assets fell for the third consecutive month, discount rates rose yet again, this time breaching the 6% threshold. In fact, discount rates have increased by 100 basis points over the last four months and haven’t been this high since May 2009, making this a very favorable economic environment for plan sponsors.”

Milliman projects pension funding status to increase to 104.4% by the end of 2023 and 105.2% by the end of 2025, assuming the current discount rate of 6.20% is maintained and assets return an annualized 5.8%.

In an optimistic scenario, with interest rates reaching 6.3% by the end of 2023 and 6.9% by the end of 2024, with annualized asset returns of 9.8%, funded ratios could climb to 106% at year’s end and 118% by the end of 2024. In a pessimistic scenario, assuming 6.1% and 5.5% discount rates in 2023 and 2024, respectively, and annualized returns of 1.8%, funded ratios would decline to 103% at the end of 2023 and 93% at year-end 2024.

Q3 Funding Also Up, Returns Down

According to the Wilshire Trust Universe comparison service for the year’s third quarter, institutional plans returned negative 2.42% in the quarter but are up 10.19% for the 12-month period ending September 30.

“The strength of the U.S. economy in the face of materially higher interest rates has led to ongoing recalibration of interest rate expectations, fueling a continued rise in bond yields,” said Jason Schwarz, president of Wilshire Advisors, in a press release. “All plan types outperformed a traditional 60/40 portfolio, while smaller plans with higher allocations to public markets generally underperformed larger plans by approximately 50-75 basis points.” 

Some Consultants See Funding Decline

Not every firm reported an increase in pension funding ratios. LGIM’s Pension Solutions Monitor reported that U.S. corporate pension funding ratios declined in October, to 102.2% from 102.6%,. A decline in equities resulted in a drop in assets that outpaced the drop in liabilities, according to LGIM.

According to October Three Consulting, pensions have endured declining equities and benefitted from higher interest rates for the last three months, and both of October Three’s tracked plans reported a decline in pension funding.

October Three’s Plan A, a benchmark plan with a traditional 60/40 asset allocation, declined a fraction of a percentage point in October but has returned 8% since the start of the year. Plan B, a largely retired plan with a 20/80 allocation, also declined a fraction of a percentage but remains up 1% year to date.

Investing November 13, 2023

Behind JPMorgan’s Underweight Equity Strategy in Target-Date Funds

As interest rates remain high, asset manager J.P. Morgan has adopted a cautious strategy to equity allocations in its target-date funds. 

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As the Federal Reserve voted to leave interest rates unchanged at its most recent meeting November 1, keeping rates at their highest level in 23 years, asset managers are taking precautions when adjusting asset allocations in target-date funds, among other investments. 

With the Fed taking the “stimulus out of the economy” by keeping interest rates high, Dan Oldroyd, head of target-date strategies at J.P. Morgan Asset Management, says this creates an “awful lot of unknowns.” 

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“For us, we want to be a little bit more cautious on the equity side,” Oldroyd says, adding that has been J.P. Morgan’s house policy for the past 18 months or so.  

Within target-date funds, Oldroyd says J.P. Morgan has a long-term goal of income replacement in retirement, and the firm is making projections over 40-year time horizons. J.P. Morgan uses long-term capital markets assumptions, updated on an annual basis, to determine asset allocations.  

But at the same time, the firm is looking at the possible “headwinds and tailwinds” within the next 12 months and will deviate from the glide path plus or minus 4% in order to protect against any fluctuations in the market.  

“We’ve been a little underweight [in equites], [and] we’ve used a little bit more cash in the portfolios,” Oldroyd says. “We want to be cautious around the glide path. If a long-term glide path has it ending at 40% equities, we’re probably sitting at 38 or 37.5% underweight. That’s going to reflect how we think things might play out for the next 12 months.” 

Oldroyd predicts the Fed will keep rates in the 5.25% to 5.50% range into 2024, which is why J.P. Morgan is maintaining underweight equity in its portfolios. 

According to data from Morningstar, as of September, J.P. Morgan’s SmartRetirement 2025 R5 target-date fund allocated 47.25% of assets to equities and 47.25% to bonds. Once the fund reaches its vintage year, 2025, Oldroyd says the glide path will adjust to be allocated to 40% equities and 60% fixed income in an attempt to balance and create more certainty for participants in these near-term retirement portfolios. 

“We’re balancing out the need to grow portfolios with the fact that, ultimately, you want to shift to a little bit more certainty or capital preservation in the portfolios,” Oldroyd says.  

When the typical participant gets to retirement, Oldroyd says that within three years, they have usually withdrawn all assets from their 401(k) plan—or have rolled the funds over to an IRA—and have begun the process of spending.  

“What we’re able to do and study is how long people stay in the plan, how long they stay invested and then what they’re spending it on,” Oldroyd says. “We have access [to this information] through our partnership with Chase, so I think we have a really interesting view into the level of spending that we need to support in portfolios.” 

In addition, in making its recent capital market assumptions, J.P. Morgan analyzed the emergence of artificial intelligence, technology, automation and energy transition. Oldroyd says some of the firm’s portfolio shifts made for the long term include reducing emerging markets equities, increasing EAFE—non-U.S. developed market equities—and increasing the U.S. large cap.  

“We’re seeing more opportunity in those two asset classes, as opposed to others,” Oldroyd says. 

He says J.P. Morgan also sees opportunity in real estate, such as in alternatives like property funds, as well as real estate investment trusts. REITs have a small presence in the equity bucket of the target-date funds, according Oldroyd.  

For participants nearing retirement, Oldroyd stresses the importance of contributing as much as possible into target-date funds . If a participant nearing retirement feels the need to play catch-up and is concerned about outliving their assets, Oldroyd says a lifetime of not contributing cannot be made up by trying to time the market and invest aggressively. 

“That’s a really difficult place to be in as a participant,” Oldroyd says. “There are things like catch-up contributions in the 401(k) defined contribution market, and by all means, take advantage of those, because you can put even more money in.  

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